After Earnings and a Rally, Is Home Depot Stock a Buy, a Sell, or Fairly Valued?

Home Depot HD released its fourth-quarter earnings report on Feb. 1, and its stock is up 20% over the last three months. Here’s Morningstar’s take on Home Depot’s earnings and the outlook for its stock.

Key Morningstar Metrics for Home Depot

• Fair Value Estimate: $263.00
• Morningstar Rating: 1 stars
• Morningstar Economic Moat Rating: Wide
• Morningstar Uncertainty Rating: Medium

What We Thought of Home Depot’s Q4 Earnings

Home Depot’s tepid fourth-quarter results reflected macro pressures like slow housing turnover and elevated mortgage rates. The results came in line with our expectations, showing a modest drop in comparable store sales and more outsized pressures on big-ticket purchases, similar to what we’ve seen over the past couple of quarters. Soft fiscal 2024 guidance was offset by time value impact.

Despite near-term market headwinds (and resulting soft earnings results), we are maintaining our long-term forecasts for 4% annual sales growth (beyond fiscal 2024) and nearly 16% operating margins, which are considered the mature phase of the home improvement industry’s growth cycle. That said, we think the current stock price implies structurally higher growth prospects, leading us to believe the shares are overvalued.

Although we think Home Depot boasts strong historical returns, helped by its brand intangible asset and scale-based cost advantages (which underpins our wide moat rating), we believe its current share price doesn’t offer compelling risk/reward and view its recent surge as overdone.

Fair Value Estimate for Home Depot

With its 1-star rating, we believe Home Depot stock is overvalued compared with our fair value estimate of $263 per share. For fiscal 2023, we expect roughly $153 billion in sales, a 14.2% operating margin, and $15.11 in earnings per share. Given the maturity of the domestic home improvement industry, we expect demand to largely depend on changes in the real estate market, driven by prices, interest rates, turnover, and lending standards. We project 2.4% average sales growth over the next five years, supported by 1.9% average same-store sales increases and helped by offerings like buy online/pick up in-store and better merchandising, which drives market share gains.

In the longer term, we forecast gross margins to hold steady over the next decade (ending 2032 at around 2022 levels or 33.5%) while the selling, general, and administrative expense ratio remains flat (around 17%) as the firm capitalizes on its scale and supply chain improvement initiatives while investing to protect its market leadership perspective. This leads to a terminal operating margin of 15.4%, a touch above the 15.3% peak achieved in 2022.

Read more about Home Depot’s fair value estimate.

Economic Moat Rating

We assign Home Depot a wide economic moat. As the largest global home improvement retailer, we believe it possesses a competitive edge owing to its brand intangible asset and cost advantage. Over the past 10 years, the firm’s sales growth has outpaced the building materials and garden equipment and supplies dealer industry’s average growth of 6.2% by 160 basis points annually (based on US Census Bureau data), an indication of the brand’s ongoing relevance.

We surmise Home Depot’s strong brand equity and extensive scale should enable incremental market share gains in the highly fragmented $950 billion North American home improvement market, on top of the high-teens market share it has amassed thus far (given the roughly $157 billion in sales in 2022).

We think Home Depot’s extensive product offerings and services have fostered brand loyalty. The firm moves 30,000-40,000 stock-keeping units in store and 1 million units online, letting consumers save time and effort by visiting one shop for all a project’s needs. To continue to engage its consumers and keep up with changing customer demand (for localization and personalization, for instance), Home Depot leverages consumer data, collaborates with its suppliers, and conducts periodic merchandising resets to better refine its assortments.

Apart from its trusted national brands, Home Depot holds eight private-label brands that primarily cater to its DIY customers, who tend to be brand-agnostic. We think those brands not only allow broader product selection and brand positioning but also provide margin benefits. While not disclosed, we estimate private-label gross margins to be a few hundred basis points above national brands. Additionally, Home Depot’s value-added services (including tools and trucks rental, installation, and remodeling) allow for the smooth undertaking of projects for its wide range of end users, which further elevates the customer experience, in our view.

Read more about Home Depot’s moat rating.

Risk and Uncertainty

We give Home Depot a Medium Uncertainty Rating owing to its strong brand recognition, which has helped stabilize sales through the cycle. Sales are largely driven by greater consumer willingness to spend on category goods, with stable existing-home price growth and decent turnover. Thanks to the maintenance, repair, and operations, or MRO, business at Interline Brands and HD Supply, pro revenue could be less cyclical, as the maintenance side can prove more consistent.

In uncertain economic times, consumers remain in their homes, embarking on improvement projects and boosting do-it-yourself revenue. Alternatively, when home prices rise, the wealth effect generates a psychological boost to consumers, reinvigorating professional sales thanks to a higher willingness to spend on big projects. A diverse consumer base helps normalize revenue even in uneven times. Currently, about half of sales are in the do-it-yourself arena, while the rest is generated from pro customers.

Although new competitors could set up shop on Home Depot’s turf, we think they would be hard-pressed to offer similar product prices, as they likely wouldn’t have vendor relationships of the same magnitude. Ultimately, the biggest brands in home retailing will still want the biggest partners for distribution, leaving a new peer in a precarious position when acquiring enough of the most sought-after products to satisfy demand.

Read more about Home Depot’s risk and uncertainty.

HD Bulls Say

• Home Depot’s continued investments in supply chain and merchandising should improve productivity and support its market leadership position in the home improvement market.
• The company has returned $70 billion to its shareholders through dividends and share buybacks over the past five years, above 20% of its market cap. In our outlook, we forecast that Home Depot will return nearly $80 billion to shareholders over the next five years.
• The addressable MRO market is around $100 billion, and Interline and HD Supply make up a low-double-digit share, leaving meaningful upside up for grabs.

HD Bears Say

• Weak consumer spending, higher interest rates, or an economic downturn could hinder sales for home improvement projects and affect Home Depot’s growth.
• IT and supply chain improvement gains could prove more challenging to achieve, as simpler efforts have already borne fruit. Further productivity efforts could face some implementation risks, creating inconsistent profitability.
• As home improvement demand continues to normalize, consumers could still shift discretionary spending away from home improvements and back into other discretionary categories.

This article was compiled by Tom Lauricella.